OK, let's recap this whole thing. Hank Paulson has been consistently behind the curve. The crisis was easily foreseeable, but it was attacked piecemeal. Then again, some of the piecemeal solutions were actually well-crafted, that included substantial protections for the taxpayers.
For example, AIG (AIG) is paying a very steep interest rate for its bridge loan and for the privileged taxpayers who get most of the equity in the firm. However, the decision was made that they had to get ahead of the whole problem and deal with it on a systemic basis after the markets started to seriously unravel.
The credit market comes to a screeching halt. So a week before Congress is set to adjourn, he recognizes the crisis and comes out with a bare-bones proposal (2 ½ pages), which pretty much says, 'Give me $700 billion to buy just about any asset from anybody I choose, at any price I choose (assuming the seller is willing) and then sell it off to anybody I choose at any price I choose. Oh and there shall be no oversight of this by any other agency or court of law.'
Congress is outraged and the public is overwhelmingly against the proposal. Chris Dodd makes very substantial revisions to the plan, including lots of oversight proposals, equity participation for the taxpayers for firms that participate in the program, caps on CEO pay to ensure that the capital being supplied to these institutions is not siphoned off to their bank accounts, and doing the deal in installments so Congress has a chance to evaluate how things are going before the whole wad is blown. The Administration was very receptive to most of these changes, and it looked like a bi-partisan agreement was about to be reached. Within the first hour of the first Senate Hearing it was clear that the Paulson plan was dead and the discussion was really about the Dodd Plan.
The Dodd plan was far from perfect. It looked like the deal was going to leave out changes to the bankruptcy law that would allow homeowners some relief if they were willing to go through the very onerous procedure of declaring bankruptcy. It was also flawed in that it overly focused on addressing the problem of too much leverage from the asset side of the equation rather than the equity side.
However, it is clear that something had to be done. There was a meeting at the White House to try to hammer out some of the final details. The meeting quickly broke down after the head of the House GOP, John Boehner, announces that he is going to oppose the deal, and at the last minute drops a brand new proposal on the table. These proposals were not mentioned at all in any of the hearings that have been going on this week. The Boehner plan, as best I understand it, calls for the elimination of even more regulations, cutting capital gains taxes and insuring these assets rather than buying them.
We got into this mess because of a lack of regulation. Insurance is available on these assets privately in the form of the ABX indices. They are one of the canaries in the coal mines that have been warning about the problem. The cost to insure has gone through the roof as risks have risen.
Hank Paulson is right on this -- the Boehner plan will not work. We need to act quickly and we need to get it right. Congress needs to be kept in session to hammer out a plan, and it should be based on modifying the existing Dodd plan, most notable by directing more of the money into the equity side of the equation. The House GOP has just made sure that nothing will be done soon.
The end of the quarter is coming up, and that will allow people to withdraw cash from hedge funds, causing them to have to sell and deleverage. That has been exacerbated since in the middle of all this, the SEC has made the fundamental investment strategy of almost every 'true hedge fund' illegal by banning short-selling. After all, they are called hedge funds because they hedge overall market risk by buying some stocks and selling short others.
The market is going to tank today, but do not try to bottom-fish it. Right now, TIPS look like a safe place to hide. High grade Muni bonds look good, but make sure that the credit rating is based on the underlying credit, not because it is insured -- insurers MBIA (MBI) and Ambac (ABK) could be strained further. On a tax-adjusted basis they look very cheap.
On the equity side, look at the gold miners. There is a very good chance that the only card left to play is monetization of debt by the Fed, which will lead to much higher inflation. Gold miners like Barrick Gold (ABX), Harmony Gold (HMY) Kinross Gold (KGC) and Newmont Mining (NEM) would be the natural beneficiaries of this.
Read the full analyst report on MBI
Read the full analyst report on ABK
Read the full analyst report on ABX
Read the full analyst report on HMY
Read the full analyst report on KGC
Read the full analyst report on NEM
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